Why Buy Bonds If Interest Rates Will Rise?

Many investors know that a bondholder receives periodic interest payments from the bond issuer and that principal is usually not due until the bond matures. But when asked to explain the difference between coupon and yield, or what the risk of a bond is, confusion and misunderstanding can exist. This article provides an introduction to bonds and a simple formula for pricing bonds.

Many individual investors wish to buy bonds to achieve a secure cash flow and to reduce their risks in the stock market. However, with interest rates at a low level, some investors are concerned that after they purchase bonds, interest rates will rise and their bonds will decline in value. This article examines the validity of this concern, certain alternatives to bonds and a proposed solution to low interest rates.

Even though the fixed-income market is supposed to be the “safe” asset class, even high-quality corporate bonds or U.S. Treasuries can exhibit levels of price volatility that might normally be associated with the stock market. How can that be? This article attempts to answer this and other questions regarding how bonds are affected by changes in interest rates.

There are many headlines warning investors about the next possible financial emergency—the lack of liquidity in the bond market. This post examines the general concept of liquidity, how it applies to the bond market, the factors that affect bond market liquidity and how the concept of liquidity applies to your investment in money market funds, mutual funds and exchange-traded funds (ETFs).

Think of the bond market as a mystery wrapped in an enigma? You are not alone. But this AAII classroom—a member exclusive—pulls back the curtain so that you can analyze individual bonds with confidence.

Wayne A. Thorp, CFA, is the senior financial analyst and a vice president at AAII. He has written extensively on the topics of technical analysis, quantitative stock selection, stock valuation and analysis, and technology. He is the program manager for Stock Investor Pro, AAII's fundamental stock screening and research database programs. Wayne is also the lead analyst and product manager for AAII's Stock Superstars newsletter and serves on the investment committee of the Dividend Investing newsletter. He has worked at AAII since 1997.